Regrettably, There's No Magic Bullet for the Hot Canadian Real Estate Market
As boomers are undoubtedly telling their distressed millennial kids and grandkids even now, Eighties-era fixes graft poorly onto Twenties-era Canada.
Photo: Tierra Mallorca, Unsplash
This spring, the soaring cost of Canadian real estate has been setting off alarm bells everywhere, particularly among young Canadians and their advocates, who believe that we may have passed a tipping point beyond which young people will be priced out permanently. A key data point feeding the frenzy came in February 2021, when the average price of a home in Toronto broke one million dollars. “The real estate game in big cities is broken,” the Globe’s Robyn Urback declared. “Young would-be buyers are better off not playing.”
The putative reasons for Canada’s super-heated real estate market may be summarized briefly: the persistence of ultra-low interest rates; increased desire for more living space brought on by lockdowns (including an unprecedented willingness to relocate and telecommute from exurban and cottage-country addresses); the attractiveness of second homes (now estimated at roughly 17 per cent of properties in both Toronto and Vancouver); unexpectedly high immigration rates in Canada’s largest cities; the massive infusion of cash into the hands of Canadians thanks to federal pandemic-related policies; and additional savings resulting from otherwise-lower consumption over the past year.
Canada is not alone in seeing rapid growth in housing prices. Since 2015, U.S. housing prices are up 32 per cent, in the U.K. the figure is 22 per cent, in Germany 40 per cent, in France 20 per cent, in Australia 13 per cent, and in New Zealand 31 per cent. Canada’s 39 per cent rise in the same period is among the most dramatic, but not entirely out of line.
For young Canadians and their cohorts in other countries, these numbers are sobering. In late March, BMO released the results of a survey on high-flying home prices showing that many first-time homebuyers were increasingly pessimistic about their prospects and intended to hold off until the market corrected.
Canadian boomers will remember the chilling effect on their own home-buying dreams of sky-high interest rates in the 1980s. But the lessons of the Eighties translate poorly in today’s real estate market. That’s because historically low rates provide little relief for first-time homebuyers. Cheap money reduces the monthly costs of carrying a mortgage of a given size. But low rates also provide access to larger loans. Stephen Brown of Capital Economics has calculated the impact of plummeting five-year fixed mortgage rates in the two years ending February 2021. “For buyers who exceed government down payment requirements,” he concluded, “the decline in borrowing rates boosted the price they could afford by 22 per cent.” That ability to afford higher prices fuels bidding wars that raise prices and, in turn, the size of required down-payments.
The psychology of prospective home buyers (and current owners) is reflected in Canadian consumer confidence data, which tanked when the pandemic struck in the spring of 2020, but have since recovered to pre-pandemic levels of bullishness and then some. In December 2020, for example, roughly half of Canadian respondents in a Bloomberg Nanos survey said they expected to see home prices rise over the following six months. This optimism appears to have been reinforced by governments’ own unprecedented willingness to borrow massively to finance pandemic recovery, post-pandemic stimulus and expensive new social programs. As University of Calgary economist Jack Mintz wrote sardonically in late April, governments are plainly not applying the home-buyers’ stress test to themselves.
As they always have, young people who want to enter the real estate market know they must make sacrifices, sock away whatever extra cash they can, and bide their time in the cheapest rental housing they can find. A 2019 survey conducted by Sotheby’s International Realty Canada (SIRC) found that 51 per cent of Canadians aged 20 to 45 were dining out less, 45 per cent were travelling less, and 20 per cent were delaying retirement savings contributions. One of the most important data points in the SIRC study was that 52 per cent of the Canadians surveyed were assisted by gifts or inheritances from family members. Thirty-one per cent borrowed money from their own RRSPs, presumably in the knowledge that, according to present tax rules, it would have to be paid back.
Canadians need hardly be reminded that there is an intergenerational aspect to the issue of affordability. In early April, a Strata survey revealed that older Canadians who are presumably profiting from real estate windfalls are making their own sacrifices to underwrite the ambitions of their kids. “Ontario's baby boomers are selling their (typically larger) homes to help their kids break into the housing market,” reported realtor Galina Sheveleva. “When seniors would sell in the past, it was strictly to downsize. But there’s this trend where older homeowners are cashing out, so they can help their children with a down payment.” A study by Mortgage Professionals Canada confirmed that “$2.8-billion was withdrawn last year from home-equity lines of credit for the purpose of gifting or lending money to a family member to buy a house.”
To improve affordability more broadly, however, particularly among young people who have little or no access to intergenerational equity, no easy options exist.
Tougher mortgage-qualification rules, for example, might limit price increases, but those rules would be particularly constraining on the young buyers who need large mortgages to access the market. Similarly, lengthening amortization periods to reduce monthly carrying costs may, like low interest rates, only contribute to upward price pressure.
Another suggestion—the so-called “nuclear option”—involves amending the capital-gains exemption on Canadians’ primary residences. This option has gathered sufficient popular momentum that economists have begun gaming it out. But as every politician well knows, the political consequences of such a policy shift would be seismic. This is because the capital-gains exemption has for generations been a pillar of the Canadian social contract. Removing it would be “an atom bomb on the retirement savings of Canada’s vast middle class,” said Tim Hudak, chief executive of the Ontario Real Estate Association and a former Ontario P.C. leader. “People will simply stay in their homes longer, maybe to the last parts of their lives, and that means that starter homes and move-up homes won’t come on the market.”
For its part, the Canadian real estate industry prefers policies that expand the housing supply. The same is true for the banking sector. In mid-April, for example, Scotiabank announced that it would commit $10-billion to support CMHC efforts to increase housing affordability, with an emphasis on providing investors and “corporate builders” easier access to mortgage credit.
Reducing red tape will also help. In November 2020, a report from the C.D. Howe Institute argued that “high municipal housing charges and taxes” were having the effect of dampening new-home construction and thus contributing to the housing shortage. In Vancouver, according to this study, “housing regulation costs added a stunning $644,000 extra cost to an average new house.” Elsewhere in Canada, including Toronto, Victoria, Calgary and Ottawa, the premium was roughly $230,000 per new house. The C.D. Howe report thus recommended the reduction or elimination of land-transfer taxes, suggesting that the resulting revenue shortfalls could be met by increased property taxes. But, again, the political fallout from such a policy would be seismic, pitting (the many) Canadian homeowners against (the few) Canadians who are contemplating a home purchase.
There is, in short, there no magic policy bullet. The most practicable solutions available to policy-makers emphasize rebalancing supply and demand in the real-estate market and will therefore take years to realize. Prospective first-time home-buyers—and their older relatives—appear to be resigning themselves to this hard reality, but only grudgingly. A Nanos poll published yesterday (May 12, 2021) revealed that some 70 per cent of Canadians are “anxious” about the real estate market. Nearly half of those surveyed said they were “at least somewhat in favour of the Bank of Canada raising its overnight rate to slow the rise.”
But as boomers everywhere are undoubtedly telling their distressed millennial kids and grandkids even now, Eighties-era fixes graft poorly onto the Canada of the post-pandemic 2020s. Canadians—and Canadian governments in particular—are gambling that near-zero interest rates will persist indefinitely. This may seem like a rigged game for young home-buyers, but it’s the only game in town.